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Fed to Press Banks to Reduce Liquidity Risk

Bernanke says regulators will encourage banks to rely less on wholesale funding.

Federal Reserve Chairman Ben S. Bernanke said the Fed plans to avert strains in the banking system by pushing financial companies to better manage liquidity risk and reduce reliance on wholesale funding.

Regulators “will continue to press banks to reduce further their dependence on wholesale funding, which proved highly unreliable during the crisis,” Bernanke said in a speech yesterday in Stone Mountain, Georgia. “Banks of all sizes need to further strengthen their ability to identify, quantify and manage their liquidity risks.”

Fed tests of whether banks companies could survive a severe recession have strengthened the banking system and aided economic growth, he said in his speech. In response to audience questions, he also said that expansionary monetary policies in the world’s largest economies are “mutually constructive.”

Wielding new powers under the Dodd-Frank Act, the Fed has compelled the largest banks to retain earnings and strengthen their buffers against losses. The Fed said last month that 17 of the 18 largest U.S. banks -- including JPMorgan Chase & Co. and Goldman Sachs Group Inc. -- could withstand a deep recession while maintaining capital above a regulatory minimum.

“It is positive for the recovery that banks are also notably stronger than they were a few years ago,” he said. “The use of supervisory stress tests -- a practice now codified in statute -- has helped foster these gains.”

Bernanke, 59, has led central bank efforts to minimize the odds of another taxpayer bailout following the 2008-2009 financial crisis. The Fed chief didn’t offer detailed comments on monetary policy.

Bernanke also didn’t speak about the economic outlook, while saying “the economy is significantly stronger than it was four years ago, although conditions are clearly still far from where we would all like them to be.”

Monetary stimulus in advanced economies “is providing additional support for other countries through stronger financial markets, more exports,” he said in response to an audience question. Bank of Japan Governor Haruhiko Kuroda last week announced an initiative to double the monetary base in Japan to end the nation’s deflation.

When the Fed tightens policy, it will use increases in the interest rate on excess reserves as its “principal tool,” he said. He didn’t comment on the timing of any increase in interest rates, focusing largely on regulatory topics.

“The results of the most recent stress tests and capital planning evaluations continue to reflect improvement in banks’ condition,” Bernanke said. The firms, also including Bank of America Corp. and Citigroup Inc., represent more than 70 percent of the assets in the U.S. banking system.

Regulatory Capital

A measure of regulatory capital, Tier 1 common equity, more than doubled from the end of 2008 to the end of 2012 for an increase of nearly $400 billion, Bernanke said.

“Higher capital puts these firms in a much better position to absorb future losses while continuing to fulfill their vital role in the economy,” he said at the Atlanta Fed’s 2013 Financial Markets Conference.

The KBW Bank Index, which tracks shares of 24 large U.S. financial institutions, has risen 8.7 percent this year, compared with 9.6 percent for the Standard & Poor’s 500 Index, as of yesterday. The S&P 500 increased 0.6 percent yesterday to 1,563.07.

Banks have also improved their liquidity, Bernanke said.

“Banks’ holdings of cash and high-quality liquid securities have more than doubled since the end of 2007 and now total more than $2.5 trillion,” he said.

Projected losses for the 18 biggest banks would total $462 billion over nine quarters under a scenario of deep recession and peak unemployment of 12.1 percent, the Fed said last month in the release of stress test results.

Bernanke told Congress in February he wants to end investor perceptions the government will bail out the largest U.S. financial institutions to avert a collapse.

“We need to stop too-big-to-fail,” Bernanke said in testimony to the Senate Banking Committee in Washington on Feb. 26. “As somebody who’s spent a lot of late nights trying to deal with these problems and the crisis, I would very much like to have the confidence that we could close down a large institution without causing damage to the rest of the economy.”

Regulators and lawmakers, including Fed Governor Daniel Tarullo, Dallas Fed President Richard Fisher and Senator Sherrod Brown, a Democrat from Ohio, are pushing for more steps to prevent the need for bailouts, asserting that the Dodd-Frank Act has failed in its aim to curb the growth of large banks.

More Capital

New measures under consideration range from legislation to limit the size of big banks or require make them to raise more capital. Proposals also include regulation discouraging mergers or ensuring financial firms hold specified levels of long-term debt to convert into equity in the event of failure.

The Fed’s current approach focuses on stress-testing the banks. Under the results released last month, the aggregate Tier 1 common capital ratio of the 18 biggest U.S. banks would fall from 11.1 percent in the third quarter of 2012 to 7.7 percent in the fourth quarter of 2014.

The Fed published its first stress test of big banks in 2009, and changed the program into a more detailed capital plan review. The March tests were conducted under a format mandated by the 2010 Dodd-Frank Act, one of the most sweeping reforms of financial regulation since the 1930s.

The stress tests show the improving strength of the U.S. banking system. With the economy in the fourth year of expansion, banks are benefiting from a housing-market rebound, falling mortgage delinquencies and record-low short-term interest rates that have helped boost their earnings.

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